Money Inflation

Due to all kinds of prices rising to levels that would have seemed
inconceivable only a few years ago, inflation concerns are mushrooming
today. And if there is anyone still not worried about inflation
yet, they soon will be. Rising food and energy costs really
affect the daily lives of nearly everyone on the planet.

But inflation is woefully misunderstood,
even among financially-sophisticated folks who should know better.
I've heard Chairmen of the Federal Reserve, elite Wall
Street analysts, and countless news-media personalities claim
rising prices are inflation. This common misperception
is flat-out wrong. Rising prices alone are not necessarily inflation.
Inflation is purely and exclusively a monetary phenomenon.

If driven solely by a supply-and-demand
imbalance, rising prices have absolutely nothing to do with inflation.
If gasoline
prices rise because supplies decrease relative to demand,
this isn't inflation. It is simply the free markets at work
addressing a supply imbalance. Rising prices simultaneously
retard existing demand and entice new supplies to market, leading
to a new equilibrium level between consumption and production.
These simple economics work in everything from hamburgers to
houses.

All throughout history, inflation
has exclusively been rising prices directly driven by growth
in money supplies. If you have relatively more money competing
to buy relatively fewer goods and services, the only possible
outcome is higher prices. And although the meaning of words
gradually changes over centuries, if you look in any dictionary,
encyclopedia, or economic textbook today you'll find that inflation
is monetary.

Dictionary.com defines inflation
as "a persistent, substantial rise in the general level
of prices related to an increase in the volume of money
and resulting in the loss of value of currency". American
Heritage says inflation is "a persistent increase in the
level of consumer prices or a persistent decline in the purchasing
power of money, caused by an increase in available currency
and credit beyond the proportion of available goods and services".
I added the italics for emphasis.

So if anyone ever tells you
rising prices are inflation, realize they either don't know what
they are talking about or they are intentionally trying to mislead
you. Rising prices are only inflation if they are directly
caused by an increasing money supply. The problem is rising
money supplies often coincide with supply imbalances in specific
commodities, so usually both inflation and simple economics are
co-drivers.

For example, global oil demand
is growing as China, India, and the rest of the developing world
drive more cars and transport more goods. But supply growth
can't keep pace, as big new oilfields are exceedingly rare.
So much of oil's bull is fundamental, it has nothing at all to
do with inflation. But at the same time, oil
priced in euros has risen slightly less than half as much
as it has in dollars. So about half of the oil bull seen by
Americans is largely driven by dollar inflation.

So as you live your life in
constant sticker shock this summer, realize that varying large
fractions of the rising prices you see are purely fundamental.
Global demand is straining global supplies. Rice is a great
example of this today. But the remaining fractions of price
increases we are seeing in the States are the result of true
monetary inflation. You can thank the Federal Reserve for this
unwelcome development.

The Fed is the greatest engine
of inflation the world has ever seen. Its only function is to
create new US dollars out of thin air, every one of which is
pure inflation. Every second of every day, the Fed ramps US
money supplies at much faster rates than underlying US or global
economic growth. The result is higher prices thanks to relatively
more fiat-paper dollars bidding on relatively fewer real goods
and services.

And as if the steep fundamentally-driven
price increases we've seen in oil, gasoline, and the grains are
not bad enough, Ben Bernanke's Fed is pouring rocket fuel on
this fire. The Fed is so worried that some real-estate speculators
might actually have to take responsibility for their own bad
decisions that it is flooding the market with inflationary new
dollars at a truly breathtaking and frightening pace.

While it is a case of
the fox guarding the chicken coop, the offending Fed maintains
measures of various money supplies. For nearly half a century,
the M3 measure of US money was the broadest measuring stick.
But the Fed suddenly discontinued this popular measure, without
explanation, in early 2006. Conspiracy theorists pointed out
M3 had been growing much faster than M2, so perhaps the Fed was
trying to hide this. And provocatively M3 was killed right when
Ben Bernanke officially took the helm.

When the Fed took my M3 away,
my replacement favorite broad money supply measurement became
MZM, or money of zero maturity. It is equal to the M2 money
supply less time deposits (like CDs) plus money-market funds.
It effectively measures the supply of US money redeemable on
demand, hence available for immediate spending. While economists
argue about whether M2 or MZM is a better broad measure, my research
leads me to cast my vote with MZM.

And if you look at MZM growth
today, it is frightening. While the Fed and Keynesian (socialist)
economists argue that money-supply growth is largely out of the
Fed's control, this is a foolish thesis. If the Fed shut down
its proverbial printing presses and stopped bullying around free-market
interest rates, money supply growth would plummet and inflation
would soon evaporate. Make no mistake, the central bank issuing
the currency is to blame here!

This chart renders the Fed's
annual year-over-year growth rate in MZM along with the YoY growth
rate in Washington's lowballed Consumer Price Index. Wall Street
generally accepts the CPI gospel on inflation, so I included
CPI growth here as well to show how ridiculously improbable it
is given true monetary growth. The raw MZM is rendered in the
background. Its accelerating growth is very disturbing.

In Alan Greenspan's final years
at the Fed leading into early 2006, the blue MZM YoY growth rate
was trending lower. It was always still positive, so money supplies
were growing. But monetary growth only becomes inflationary
when it exceeds the growth rate in stuff on which to spend it.
If money is growing at 3% a year but the US economy is also
growing at 3%, then little or no monetary inflation will be witnessed.

The week Greenspan left office,
I wrote an essay on
his monetary legacy. He did a horrible job. Like a Communist
boss in old Russia, he continually tried to manipulate prices
and failed. At the time, I thought he was one of the greatest
inflationists in history. But after seeing Ben Bernanke's sorry
record since he took office, it is crystal clear that this new
central banker is trying to radically out-inflate his predecessor.

Left with low broad money growth
by historical standards, Bernanke's Fed soon started accelerating
it in late 2006. Then in early 2007 the subprime crisis erupted,
and the Fed panicked. Rather than letting reckless real-estate
speculators (both banks and mortgage holders) go under and clean
out the system, the Fed rewarded them. It started ramping money
way faster in the curious hope endemic to central bankers that
more cheap money will magically fix an imbalance that previous
cheap money created.

Until this point, MZM growth
was still near 8%. This is faster than economic growth and definitely
inflationary, but all over the world central banks inflate their
own currencies by 7% to 8% a year on average. So 8% in early
2007 was on the high side, but still reasonable in light of fiat-currency
history. But as subprime problems snowballed, the general credit
crunch hit last summer.

Again Bernanke's Fed, rather
than trying to fight inflation and preserve the dollar's purchasing
power, decided that its real-estate speculating buddies in the
banking industry shouldn't have to bear the fruit of their own
bad decisions. By the end of 2007 monetary growth was running
a scary 12%, but it was stabilizing. The Fed was gumming up
healthy free-market cleansing action with floodgates of new money.

Then in early January 2008,
the global stock markets sold off aggressively. Fears of an
impending US recession drove heavy selling overseas.
This worldwide selloff was so extraordinary that we are unlikely
to see anything resembling it again for decades. But instead
of reining in monetary growth, the Fed accelerated it. Absolute
annual MZM growth peaked at a staggering 16.7% in March 2008!

You read that right. There
were 16.7% more US dollars available for spending this March
than last! This is incredible, especially during challenging
times when the US economy was barely chugging along around 2.2%
growth for all of 2007. Sooner or later all this excess money
will eventually bid up prices. Some of this inflation will be
perceived as good, primarily the part that flows into stocks.
But the part bidding up scarce food and energy is not going
to make Americans very happy.

Now these growth rates defy
the imagination. At 12% growth compounded annually, it only
takes 6 years for something to double. At 16%, this drops to
well under 5 years. If the Fed doesn't stop this madness, there
could be twice as many dollars floating around in 5 or 6 years
as there are today. Even with modest economic growth, this means
general price levels would probably almost double. And this
inflation is totally above and beyond all the supply-and-demand-driven
global commodities bulls' increases!

Bernanke's Fed has been ramping
money-supply growth so fast that actual MZM is starting to look
parabolic even on a short-term chart. In just over 2 years under
him, MZM has ballooned 25.1% unchecked! And since the Fed almost
never shrinks money supplies, all the inflation evidenced in
this parabola is already in the pipeline. Eventually this excess
money will filter into and really drive up general price levels.

Now since MZM includes money-market
funds, stock-market performance does affect it too. So some
analysts argue that this staggering MZM growth is largely the
result of market turbulence. This thesis is problematic though.
Whenever stocks change hands, so does cash. Buyers' money is
transferred to sellers' accounts where it is still, amazingly
enough, money. Unless cash is routed into time deposits like
CDs, stock buying and selling shouldn't affect MZM all that much.
This same logic applies to bonds.

Another interesting point is
MZM really started accelerating in late 2006. But the US stock
markets didn't top until one year later. In the year
leading into its October 2007 top, the S&P 500 surged 15.9%
higher. This is a great year highly unlikely to drive heavy
stock selling and cash accumulation. Yet MZM still soared by
11.9% over this very span. The Fed recklessly running its printing
presses was the culprit, not stock selling.

Thanks to this incredible monetary
spike, a massive growing gap exists between the annual CPI growth
and the annual money growth. Since monetary growth is the direct
driver of all true inflation, shouldn't the CPI reflect this
MZM surge eventually? Theoretically yes. But since the CPI
has become a US government propaganda tool rather than an honest
inflation gauge, it probably won't. Nevertheless, this MZM surge
will certainly flow into real-world inflation and drive up general
price levels of nearly everything we consume.

Now the 5 years rendered in
this first chart really isn't all that long. While 16% MZM growth
is staggeringly extreme over this short span, is it extreme relative
to history too? Absolutely! This next chart zooms out to the
past 20 years to provide perspective. Bernanke's Fed is really
pushing the limits monetarily, blasting out shiny new fiat dollars
at the fastest rate in decades with the exception of the 9/11
crisis.

The incredible acceleration
in YoY MZM growth rates in 2007 is even more apparent in this
long-term chart. And the post-9/11 high is very telling. By
the looks of this, the Fed sees bailing out real-estate speculators
as its highest priority since trying to maintain a functioning
economy in the intense fear and uncertainty after the September
2001 terrorist attacks! The Fed is clearly scared today, and
it is doing the only thing it can do. Inflate.

Bailouts are terrible for capitalism,
even for the people getting bailed out. When speculators make
bad decisions, they should face the full consequences so they
learn from their mistakes. Failures are good because the assets
used inefficiently and unprofitably by the bad speculators are
naturally redistributed by the markets to those who will manage
them efficiently for profits. Yet the Fed willingly keeps short-circuiting
this important process which keeps making matters worse.

In late 1998, the Fed ramped
money supplies to try and stave off necessary deleveraging following
the Russian debt default that led to the implosion of elite hedge
fund Long-Term Capital Management. But that deluge of cash soon
found its way into stocks, particularly the speculative tech
sector. The Fed's LTCM bailout directly led to the tech-stock
bubble by providing the surge in liquidity that drove the latter
parabolic.

Then when the tech bubble burst,
Alan Greenspan desperately tried to bail out stock speculators
by slashing
rates and radically ramping monetary growth in early 2001.
Later that year when MZM growth was already 16% yet stocks kept
grinding lower, the 9/11 attacks hit. So the Fed flooded the
reeling system with even more newly-created money and pushed
MZM nearly parabolic with staggering 22% annual growth!

But all this excess cash had
to go somewhere too. Eventually all money the Fed creates will
bid on something. Greenspan's massive monetary growth in 2001
directly led to the housing bubble that he brazenly tries to
accept no responsibility whatsoever for today. The torrents
of excess money, which the Fed refused to take back out of the
system after 9/11, flooded into real estate. And then that bubble
started crashing in late 2006.

See the pattern here? The
Fed gets scared because some speculators might actually lose
on their bad bets so it floods the system with money to help
them. But all of the money created in these huge surges eventually
has to find a home somewhere, so another bubble is born. And
then that bubble pops, scaring the Fed more. So it ramps money
growth again, birthing a new bubble. It is a nasty vicious circle.

Other than abolishing the unconstitutional
abomination that is the Federal Reserve, which isn't going to
happen since Washington would then have to live within its means
financially, all we can do is try and anticipate the Fed's bubbles
and deploy our capital to ride them. Without a doubt, the massive
surge in MZM under Bernanke is going to go somewhere. I suspect
it will flow into and eventually create bubbles in the next hot
sector, commodities.

It is ironic that the surges
in money never go into the sector the Fed is trying to bail out.
The tech-stock bailout attempt went into housing. And the housing
bail out is already starting to flow into commodities. This
is a serious problem for the Fed. When monetary inflation hit
tech stocks and housing, people saw it as good. But when monetary
inflation hits commodities, most folks aren't going to be thrilled.

Despite their surges so far,
commodities are not in bubbles yet because the majority of mainstream
investors aren't heavily involved yet like they were during the
peaks in the tech-stock and housing bubbles. Bubbles are impossible
without popular manias. And if Bernanke's inflation indeed
flows into commodities, they could prove to be the biggest bubbles
yet. This money inflation gravitating towards an already fundamentally-hot
sector is like a perfect storm of bullishness.

Today something like 2/3rds
of the world's population is starting to strive to live and consume
like we blessed few do in the first world. Yet the world's commodities-producing
infrastructure was never designed to cope with such immense and
fast-growing demand. It will catch up eventually, but prices
will have to rise and stay really high for a long time to entice
enough new capacity online to supply increased consumption.

So even if we were on a gold
standard with no fiat-paper inflation whatsoever, commodities
prices would still have to rise tremendously. But to
have such a fundamental secular bull coincide with massive monetary
inflation is incredible. Relatively more dollars bidding on
relatively fewer already-fundamentally-scarce commodities is
going to seriously amplify these bulls. And eventually the general
public will flood in to speculate leading into the final apex,
driving a superspike like never before witnessed.

Accelerating monetary inflation
on top of global supply shortfalls is a truly incendiary mix.
It leads me to believe we haven't seen anything yet in commodities.
At Zeal we've been riding these commodities bulls since the
early 2000s. We were early
contrarians starting way back when everyone thought commodities
would never rise again. Since then our subscribers have made
fortunes mirroring our trades.

So if you want to thrive in
the coming inflationary times, subscribe
today to our acclaimed monthly
newsletter. We are constantly researching the markets, looking
for high-potential opportunities in commodities stocks. You
can learn from our hard work, see the logic behind all our real-world
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you wish. The opportunities approaching are immense.

The bottom line is the commodities
price increases we have seen lately are not all inflation. A
large portion, the majority in most cases, is due simply to global
imbalances in production and consumption growth. Inflation is
purely a monetary phenomenon, it has nothing to do with supply
and demand in individual commodities. It has everything to do
with relatively more money chasing after relatively fewer goods
and services.

But while investors wrongly
attribute too much to inflation today, a massive surge in real
inflation is already baked into the pipeline. Bernanke's Fed
has flooded the markets with cash in a futile attempt to bail
out real-estate speculators. This new money has to go somewhere,
and it will probably be commodities. We may as well buy in ahead
of it and reap the big profits to come.

Adam Hamilton, CPA

May 16, 2008

Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!